An Uncertain Prescription: Are Tax Exemptions for Nonprofit Hospitals an Efficient Way to Fund Indigent Care?

By David, Guy; Helmchen, Lorens A. | Regulation, Summer 2006 | Go to article overview

An Uncertain Prescription: Are Tax Exemptions for Nonprofit Hospitals an Efficient Way to Fund Indigent Care?


David, Guy, Helmchen, Lorens A., Regulation


As health care expenditures increase faster than inflation and as federal and state legislatures and executive branches face competing claims on their budgets, policymakers have been reassessing the effectiveness of financing mechanisms that provide health care for the poor. In turn, hospitals--traditionally the principal providers of indigent care--have faced uncertainty over whether government programs such as Medicare and Medicaid will continue to subsidize indigent services.

Scrutiny is also intensifying for a lesser-recognized public subsidy for indigent care: the exemption of private, nonprofit hospitals from property, sales, and income taxes. The tax exemptions are, in the words of researcher D. Pellegrini, part of a "bargain" that was "struck between the hospital and the community: a hospital would treat patients who were unable to pay, and the government would grant a tax exemption to the hospital."

Legislators and patient advocacy groups have been asking whether nonprofit hospitals are fulfilling their end of the bargain. "What is the taxpayer getting in return for the tens of billions of dollars per year in tax subsidy?" Bill Thomas, chairman of the House Ways and Means Committee, recently asked at hearings on tax exemption standards for hospitals. The Senate Finance Committee is conducting a survey of at least 10 tax-exempt hospital systems to gather information on actual practices regarding the provision of charity care and collection behavior.

In addition, increased scrutiny by the Internal Revenue Service is likely to affect nonprofit hospitals, which account for close to half of the total revenues of Section 501(c)(3) organizations in the United States. More than 30 lawsuits have been filed in federal court against nearly 300 tax-exempt hospital facilities in 15 states, alleging that the hospitals have "failed to meet their charity care requirements because of certain billing and aggressive collection practices against uninsured patients." State and federal legislators and officials are increasingly keen, it seems, on ensuring that nonprofit hospitals stick to the bargain.

The quid-pro-quo of community benefits in return for tax exemptions is only one of several financing mechanisms that municipalities can adopt to ensure the provision of health care services for the poor. For example, the community could operate the hospital itself, as in the case of county hospitals, or allow private hospitals to charge all patients regardless of their income and then the community would reimburse the providers for the indigents' hospital visits, as in the case of the Medicaid program.

From this perspective, nonprofit hospitals' tax-exempt status is justified only if its benefit to the community outweighs its cost and if it is the most efficient means to finance healthcare for the poor.

MEASURING THE VALUE OF TAX EXEMPTIONS

In many local markets, nonprofit hospitals compete with for-profit hospitals, which are not tax exempt and have become increasingly similar to nonprofit hospitals in terms of services offered, populations served, and overall management practices. Thus, for-profit hospitals' tax revenue offers an alternative option for governments to finance community benefits, suggesting that for-profit hospitals are the appropriate comparison group for evaluating nonprofit charitable behavior.

In the existing literature, there is neither a consensus on the services that should be included in the calculation of community benefits nor agreement on the appropriate benchmark that should be used to assess whether the community benefits provided by nonprofit hospitals are large enough. Most studies ignore for-profit hospitals altogether. For example, N. M. Kane and W. H. Wubbenhorst, in a 2000 Milbank Quarterly article, compared potential tax revenues to the hospital's value of tax exemptions. Yet, the value of tax exemptions for an individual hospital may exceed their social cost. …

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